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The audit model and the profession

Financial statements no longer give insight into companies’ changing fortunes. So auditors must evolve themselves in order to remain relevant as a profession.

Has the quality of the audit improved since the 2007 financial crisis? If so, have stronger regulatory oversight and standards driven the improvement, or has the profession done so?

In my opinion, there’s absolutely no doubt that audit quality continues to improve significantly. But the answer to your question is far more complex. We’ve recognized as a profession, and certainly at KPMG, that we have to step back and evaluate not just financial institutions but other companies from a more holistic risk perspective. The entire world learned what can happen if there’s a crisis of confidence and liquidity. But there’s much more work to be done. One of the knee-jerk reactions to the crisis was to increase our level of rigor over compliance and I’m not convinced that we’re focusing our efforts in all the right areas. We’re not getting the “biggest bang for our buck.” In addition to compliance issues, there are significant business issues that give rise to audit risk.

Do auditors have the capability to give anything more than a binary pass or fail audit opinion? Is the profession sufficiently sophisticated to deliver a more narrative-based opinion?

Yes, because as the auditors of a company, we have broader access to a company than almost any other entity or profession. I’ve been an audit partner my entire career and I’ve been the lead signing partner on major global multinational companies, and in that role you look across so many different things – IT, HR, legal, compliance, finance, control, etc. So, to me there’s no question that we’re in a unique position to deliver more than a binary report. I think what we’re finding is delivering a binary report is not providing investors with all of the insight that they need in order to make their investment decisions.

Investors are making their decisions based on adjusted non-GAAP earnings and non-financial metrics. They’re making decisions based on a company’s pipeline, same store sales growth, oil and gas reserves, etc., all of which might be derived from the historical financial statements but they’re not in accordance with GAAP or necessarily derived from financial statements or systems. It’s those non-GAAP measures, both financial and non-financial, that are driving the market capitalization of the world’s biggest companies. But those metrics typically have no form of independent attestation. I think in the future the market and investors are going to need, or potentially demand, some form of independent assurance.

What meaningful improvements or innovations in the audit has the profession made recently? What is the most meaningful improvement or innovation?

I can’t tell you that we’ve been hugely innovative, but we have a mandate to be innovative now which is coming in part from the global financial crisis. Let’s look at one example – how we can use predictive data analytics. Is there a way that auditors can use external information to try and derive a predictive amount that they would expect to see in a company’s financial statements with respect to, say, revenue? Predictive analytics can test what the company’s telling you. If what it tells you is materially different from what the data has predicted, then you need to understand why.

What is the single largest weakness remaining in the audit (or the profession) and what could be done to rectify it?

As auditors, our primary product is based on a historical set of statutory financial statements. However, stakeholders are clearly increasingly basing their decisions on information that resides outside of those statutory accounts. That is the single biggest issue, I think, that we have as a profession. We have the opportunity to provide more significant insight to investors and other stakeholders.

Is there merit in extending the audit beyond the financial statements or even the annual report? If so, what would you suggest? Who wants this? Who will pay for it?

I believe that we recognize we have a broader role to play in society and have to find a way to deliver on that. We can do so by giving broader assurance on information that matters to stakeholders. I apologise if I sound a little `Pollyannish’ but people have high expectations of us, so we have to broaden our service offering and delivery. We have to provide assurance on areas beyond the financial statements if we’re going to meet society’s expectations.

Larry is the Global Head of Audit. He has been with KPMG for 30 years, having spent 17 of them as a SEC Reviewing Partner. Based in New York, Larry is a member of the Board of Directors of Park Indemnity Limited where he chairs the Audit Committee. He has served as the lead audit signing partner and SEC Reviewing partner on numerous Global and Fortune 500 companies.